Key takeaways from our recent meeting with PGCIL’s management: (1) Order book could double — visibility can improve substantially if PGCIL receives Rs 500-600 bn projects on nomination basis (cost-plus) to link 7-8 GW of wind projects in Gujarat and Tamil Nadu. This will clear overhang of low visibility; (2) Core RoE of 15% in FY18 appears suppressed (vs. 16.3% normalised) due to wage provisions (one-off) and under-recoveries in O&M; (3) Expects CERC to maintain base RoE at 15.5% in upcoming tariff policy given the need for transmission to keep pace with robust renewable capacity addition; we expect CERC to reduce base RoE to 14% due to PGCIL’s strong free cash which suffices to meet growth; and (4) FY19/FY20 capitalisation at Rs -270 bn; however, FY20 capitalisation includes a single large HVDC project Rs 200 bn, which if delayed will slip to FY21.

PGCIL’s era of high earnings growth (FY08-FY13:19% CAGR; FY13-FY18:16% CAGR) is over and we expect considerably lower earnings CAGR of 7% over FY18-20 due to (1) flat capitalisation of Rs 250 bn p.a. And (2) assumption of lower base RoE of 14% from FY20 vs. 15.5% currently. We believe even if capitalisation in FY20 turns to be lower at Rs 100-150 bn vs. management’s guidance of Rs 250 bn due to deferral of commissioning of HVDC projects by a couple of quarters, it would not impact the earnings trajectory considering its benefits would have reflected only from FY21. Also, the award of Rs 500-600 bn of projects on a nomination basis would extend the growth horizon beyond FY21 by a couple of years, but not materially alter the earnings growth trajectory.

We believe the key overhang is the upcoming CERC’s tariff policy for 2019-22. Historically, PGCIL’s core RoE declined from 18-19% over 2009-14 to 15-16% over FY15-18 despite CERC maintaining the base RoE (refer exhibit 7). At CMP, PGCIL’s stock valuation appears cheap at 11x FY19/FY20E P/E despite superior business model of take-or-pay and on cost plus, but is justified due to slower earnings growth and regulatory uncertainties. Maintain HOLD with TP of Rs 197.